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Deutsche Bank Leveraged Finance

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All right. Good morning. Ready to kick off day two here for the
media track at the Leveraged Finance Conference.
Very pleased to have Sirius XM back again this year. To my right
is Dave Frear, the CFO, Barbara Daniel and Hooper
Stevens from the team are in the front row of the audience here.
And I think we're going to jump right into questions,
discuss a lot other current happenings and growth opportunities for
the company and we will try and save some time at
the end for any questions you guys might have.
Q&A
<Q>: So Dave, again thank you for being here. And we'll start out
with we had around you had around 26.3 million
subscribers today. You've recently raised your guidance for the
year for net sub adds. Can you talk about kind of the
main driver behind that? And what do you think is going to be the
biggest driver for the push ways in that further going
forward?
<A>: Okay. Well, thanks for having us out here and thanks
everybody for taking the time. So the biggest drivers and
the changes in the guidance obviously is strong auto sales, in
particular the mix of the auto sales, right. So we we've
focused and provided guidance early in the year on total
subscribers and didn't distinguish between the self-pay and
total subscribers because the difference between the two is really
the change in the inventory of paid trials on any given
day. All right?
So we just didn't want to take a position that really in the years to
which way market share was going to go in the auto
industry and not necessarily even how big car sales we're going to
be, because to be quite honest, we really don't know.
We just sort of follow what everybody who follows the auto
industry sales for new cars sales.
So coming to the end of the summer, where our paid trials are the
two biggest sources and our paid trials are Ford and
Chrysler that, the shares like strong Chrysler, I think it has
something up this morning to say that I think their
September sales are up 19% over the last year, that have really
been not going to cover up the ball. That benefits the
paid trials, right and so we just have pretty good visibility as to
where it's going to end the year now with last few
months in.
So we try to refine the guidance. We remain confident in the
guidance we've given. Self-pay side is 250 million on the
self-pay side, honestly everything is performing right alongside our
expectations.
Going forward, let's go to drive things. New car sales are
important, but we've got this really rapidly developing new
follow coming from the used car side. So as you move out of
we've seen that last couple of years provide a healthy
amount of business for us and it's going to grow pretty
dramatically in the next several years.
<A>: And maybe that's the answer to this start line, but the
audience here tends to be very focused on cash flow. SAAR
has been and car sales have been great over the last year plus.
What happens if and when car sales actually start to
slow down a little bit and I think you kind of just answered that,
before I even asked, but how should we think about the
cash flow of the company coming in once car new car sales start
to slow down?
<A>: Well, on the there's something on the expense side of the
changes, right. So we only put the sub sales in the car
slots, when they are built and it goes in upfront, right. So actually
if SAAR deeps, there is a short-term improvement in
our cash flow, because we're obviously not investing in the radio
as they go into the vehicles.
And then after they come out of their trials, which is three to 12
months later is roughly where you would see most of
the cash flow impact from having fewer subscribers converting
through. But the as you point out the offset to that is
this developing used car trial follow up, right. So, if you kind a
look over the long-term where we are going, we started
this year and I think we said in the call at the beginning of the year
that we expected to put about $15 million vehicles
through trials this year, roughly $11 million on the new car side
and roughly $4 million in the used cars side. Well, that
sort of $11million-$4million split out of $15 million trials is much
different than the way cars are actually distributed,
car sales are distributed, right.
If you look at total car sales, call it may be something in the $50
million range and what you have is effectively $35
million used cars and $50 million new cars. So they have this sort
of 2.5 to 1 ratio, where we flip the other way. So our
opportunity over the course of the next sort of eight years is
actually going to go the other way. And then in a few
years, our used car trials will actually exceed our new car trials. So
we will have some sort of a buffer against what's
there is got to be a downturn somewhere in the future for the new
car sales.
<Q>: All right. Couple of more question on new cars, I want to
talk more about used opportunity but new car
penetration at around 70% now, is that the right level that for
penetration you think for the foreseeable future?
<A>: Yeah. I think it's a good number. I mean the other companies
will decide what the penetration is and I think that
will constantly see it changing but we think 70% is a good number
to use for now.
<Q>: And your conversion rate now around 42%, what variances
have you seen kind of recently as you pushed that
penetration higher with regards to that conversion rate?
<A>: Well, definitely over the years or a long period of time,
we've seen conversion rate come down as penetration
goes up. But when you do the math, you end up with more
conversions, so it's still been great for the business.
You know, a lot of people ask us, [ph] James, when are you going
to do to make conversion like go back up or okay,
we're working really hard at it. And I think we have a really solid
business with conversion rates where they are. I'm
hesitant to be [indiscernible] just too much on what we can do to
raise rates when you have tens of millions of customer
transactions that simply occur within the statistical range and the
customers seem to be saying what it is they want.
So if if there is going to be a change, there would have to be
some underlying change in mix of the opportunities. We
are a long way into new car sales, now we have 65 million vehicles
roughly on the road and that's a lot of transactions
when we have a statistical results. So I think it will probably stay
in range that that's in.
<Q>: Okay. And as credit has opened up a little bit over the last
couple years coming out of the recession for
consumers, people buying cars, I think you've seen more releases
coming to your picture as well, but the ratings on the
credit or people taking that credit falling. How do you think about
that and that change in mix?
<A>: So, we have been above 60% penetration of new car sales for
I want to say five years now, right. So and we sort
of moved away from 60% to 70%. And there has been there has
been a very high participation of sub $75,000
incomes in new car sales, and we certainly, there is very high
participation in the millions of used cars that we're seeing
go through .
So I think we're seeing the effects of how sales are distributed and
at the margin, kind of the you would think whether
discretionary product that a more income sensitive household
would be somewhat less likely to convert, but all that
being said it's all in the numbers already.
<Q>: Yeah. On price points. You have taken the cost of your
offerings up. To me, it was surprisingly minimal impact
on churn. How do you think about the timing of future price
increases and also kind of the size of them?
<A>: So, here we didn't change prices forever for a decade.
<Q>: Right.
<A>: And we added a lot of content and so ultimately, we raised
prices and over a couple of years, honestly we raised
them a lot. So I don't expect to have any kind of increases like
what you've seen in the last few years, but I do think that
like every other business cost rise overtime, price for your product
needs to rise overtime. So I think you should see it
sort of gently rising inflationary trend.
Whether or not we sort of increase stated prices or reduce
discounts that we provide for other packages, there's lots of
different ways to move the price schedule around, but I think you
should think of gently rising prices overtime.
<Q>: Okay. Shifting gears back towards the used opportunity. One
in four cars give or take have enabled vehicles with
your radios in them. How are you promoting that opportunity, if I
go to buy a used car, is it something the dealer is
going to pitch to me and how do you think about where you would
like to see the conversion rates on those vehicles go
over the long run?
<A>: So, I will take the second part first. I'm really surprised that
the strength of the conversion rates in used car trials.
The when we're running these models sort of five years or six
years ago, I didn't have any numbers that started with a
three on them, right. So the fact that we're in the low 30s is a big
surprise to me pleasant surprise, I'm thrilled with it,
and hope we can keep it as long as we can. When you think about
it overall, we're building the fleet out from 65 million
to 150 million cars if you gave me a forward and say jeez you're
going to have 30% penetration of your 150 million
cars that's a double from where we are today. I'd punch that ticket
right away.
So, I'm thrilled with where the conversion rate is today
[indiscernible] the implementation of the dealer that is hard
work every day, right, because the job of the dealer is not to sell
satellite radio, it's to sell a car, right. And if the
customer is interested in the car, getting him to sign the papers as
fast as you possibly can and don't get anything in the
way, right. Maybe sell them some sort of coating for the
windshield or for the paint on the way out the door where you
have 50%, 60%, 70%, 80% margins. And so the F&I guys are
working hard. But what we're trying to do with the
dealers is we have field teams that go out and work with dealers,
and just sort of make sure they are [indiscernible]
have guys who are out and go there on delivery day and see how
their setting up the customer. We know that we get
better conversion when the customer is shown the radio, right. And
we're sure the radio is on.
In the used cars side, we don't always know the radio is on, right.
It's not like rolling off the factory where we have
specialized equipment with the automotive makers that ensures
100% the radios are on when they roll off the line. In
used car lot, we don't necessarily know the cars there, that we can
send out signals and we think we know it's favorable,
while if it's not turned on. So there are lots of little things along the
way. I think the good news is, is that with what I
would consider to be a lot of conversion opportunity breakage
from salesman not talking about the product from radios
not being on, when they roll over the curb in the used car lot, we
still have low 30s conversion rates, which when you
think about the size of the breakage, even more shock.
<Q>: Yeah, okay. The cars has always been kind of a domain of
terrestrial radio, the real home base. You've carved out
a healthy niche there. As the OEMs roll off more and more
connected cars over the next few years, where the dash
becomes like our phones and you can just you'll be able to click
on a streaming option AM/FM series, how does that
change the competitive dynamic?
<A>: So, I will tell you, so first of all it definitely changes it.
Secondly, I'm a lot less worried about it now than I was
40 years ago. All right, so four to five years ago, we are looking at
smartphones in the street, thinking that well this is
really going to bring the streaming services in and in fast.
But we've gone from zero smartphones on the street to over a 150
million in the United States and obviously we can't
find the effect of the streaming services on demand for our service.
And interestingly enough, and talking to some of
the trust or radio guys that they can't really find the effect in
listening for terrestrial radio. So I think a couple of things
have happened here. One is, I think the size of the pie has gotten
bigger. So when I was young, believe it or not, we had
transistor radios, all right the nuns have taken away from you
during the World Series, and the smartphone has
effectively become [indiscernible] transistor radio. And so I think,
there is "listening to radio" that simply wasn't there
for the last 30 years that's come in the play.
And from a demand perspective, I don't know where all that
listening is coming, I know the pie has gotten bigger and
we hear the digital downloads are declining, and we know that our
listening hasn't been affected.
From what I hear from the terrestrial radio guys, they don't feel
like there's has been affected, which would lead you to
believe that the music streaming services are sort of competing
with one another and with the playlists.
So when it comes to the car, I guess the caution will be is, will be
the product be different? And because if it's just
music listening that's not radio, it's not news, talk, sports, weather
and music.
And so we'll have to see and another question is, how long is it
going to take to get to the car? When it does get to the
car, will the apps work as well as they do on your smartphone?
And the answer to that last question is probably not
initially, there will probably be some breakage in how it gets done.
And so I think it's connected car, is great
opportunity for a lot of different people including us, but it's going
to take a very long time to really roll out.
<Q>: And as you think about the best differentiator, between you
and these competing options or potentially competing
options, is the main drivers is your content? Is it the lack of
commercials? Is it [indiscernible] like, how do you?
<A>: Well. I think it's a diversified content. I actually met the
guys, who founded Sirius back in 1993, and I talked to
them for years, as they were sort of putting together the business
plan and then in the late 90s something happened,
Napster came and their business plan totally changed. They
realized the moment Napster came, music was essentially
free, because everybody was stealing it that their CD radio
business plan of the jukebox in the sky, or CD is just
playing, playing, playing, was no longer viable, because nobody
was going to pay for it. So they had to diversify and
get content that was differentiated and that's the strategy that we've
been on for 15 years now and it makes a difference.
Over people run down to us for radio, I don't know why. Though
over 200 million people listen to Radio every week
in the United States. That's just incredible. And they have a lot
more than music. We have a lot more than music, the
streaming guys keep coming into us saying, we don't understand
you have so many paid subscribers and we are glad
that they don't understand.
<Q>: We didn't get your job at the RAB. Good PR there. When
people turn off, what are the top kind of two reasons
you get out for them?
<A>: They don't want to pay for radio.
<Q>: Okay.
<A>: Right. For works, 200 million people are listening to
AMFM, 75 million people listening every week to Pandora
and three quarters of the people are listening to [indiscernible] or
pay.
<Q>: All right.
<A>: Free works.
<A>: So as we think about the connected car a little more, you've
obviously invested pretty heavily in the Telematics
arena trying to touch people in a different way within the car. It
was a little over a year ago, right before you came out
here last year that you purchased as you're and I know you don't
call it that anymore, but comparing to what your initial
targets and expectations on that were back then, how do you sit
today and how are you thinking about those initial
targets versus reality now?
<A>: We always think the connected vehicles space is like we said
in the beginning, it has great organic growth.
Absolutely no doubt that the OEMs are working hard and fast at
connecting their vehicles. And so there is great organic
growth in that business. So I think there is the opportunity as they
continue to look through the technology to head
overseas where there is an opportunity. And I still believe there is a
long term opportunity there to move into the retail
side of the margin now.
Right now, the retail side of the business right now the OEMs
have it setup is that they all have their own private
label brands and then they are hiring backend people like us to do
all the fulfillment for them. So they are the face of
the customer. They are the price point to the customer. They buy
wholesale services from us. It's a great high margin
business for us and we're thrilled with it.
But we really do believe that we're better positioned to provide a
trial of a subscription based service to a consumer,
convert them from that trial, when they churn, win them back.
That's what we do every single day and I just have to
believe that the OEMs won't be quite as good at it in other private
label products as we would be. So we're hopeful that
over time that they will be able to alter the business model. They
are in move from the wholesale business plan into the
retail end of things.
<Q>: And the main completion on that front, is it mainly coming
from the OEMs themselves or?
<A>: Well. So GM of course has OnStar and will always have
OnStar. And Verizon Telematics, which was the old
Hughes Telematics business, is a competitor in the space and then
there are some non-U.S. competitors like
WirelessCar, which is owned by Volvo, the truck-making Volvo in
Sweden and there are others.
<Q>: And correct if I'm wrong, well, you've talked about that
being free cash or EBITDA kind of breakeven this year?
<A>: Yeah.
<Q>: With growth ramping as you move forward?
<A>: Yeah.
<Q>: Okay. When do you see that being a meaningful contributor?
<A>: Well, I mean look, it's a business that we brought for I think
less than 2% of our market cap and it's sort of
similarly sized. So I think that it'll develop well on its own
becoming material to the consolidated results of Sirius XM
will take quite some time.
<Q>: All right. Just jumping back to content again real quick.
Obviously, you mentioned that's a big play for you in
attracting people. What have you been doing recently to expand
and kind of evolve your content offerings whether it's
towards Hispanics or women and then also any upcoming renewals
that we should be thinking about, that could have
an impact on costs.
<A>: So we've said for a longtime that we believe our content slate
is complete. All right, there is nothing there's no
must have piece of content we are missing. All that being said
there are still lots of great properties out there that are
great additions to the business. So recently we have been at the
Today Show. I mean, what a fantastic brand. Great
loyal audience and the people at the Today Show have been great
partners. They comment on Guest DJ'ing at the
channel during the launch, a whole drive that [indiscernible]
coming on the first day with the moving from Long Island
I mean it was really cute.
And they have been great partners, Ellen DeGeneres coming on
that [indiscernible] radio that launched this weekend. I
mean this is the guy that can sell out Yankee stadium in three days
and like 24 hours, right. So just really there's a lot of
fantastic talent out there and Scott and his team, I think to a
spectacular job of finding those things that resonate with
audiences around the country.
Not everybody's the same, it's 300 million out there and they like
different things and our job is to provide the very best
of those different things for them. We obviously have the NFL and
Howard coming up at end of next year again two
great brands, Howard obviously a legendary performer who we
had just a fantastic relationship with for a longtime. We
would expect to continue our relationship with both the NFL and
Howard with new contracts and those will work until
[indiscernible] in due course.
<Q>: Just thinking about NFL for a moment, we've seen massive
price increases for sports on the television side. Does
that not translate for what you are looking at in your mind for that
contract renewal just given that they're on radio, they
want to expand their brand to and you have another option in the
car, how should we think about the cost?
<A>: Yeah. I think to, what are we to the NFL, which is a fantastic
global brand, it's main business plan monetizes on a
different platform, a different technology, it's really not only the
insane experience for fans, but all of the video rights,
all the different ways they can packaged, satellite radio is an
additional form of fan engagement. So it's, I think the NFL
would like their product to be on as many platforms as possible,
they want it on a mobile, they want it on AM & FM
Radio, they want it on satellite radio. So I think the dynamics
behind it are a little different than it is on the video side, I
don't think you can translate them straight across.
<Q>: All right. One last question on the business and now I want
to put my credit hat on XM capital structure
questions, but recent headlines obviously on music royalties,
lawsuit in California verdict went not your way, can you
may be just talk about what that decision was by that Judge in LA
and what it means for your cost structure and your
business?
<A>: So, there were two California cases, right, and the first one
was a state Judge Strobel, who issued a tentative ruling
that said there is no public performance right under California law,
that's a state law Judge opinion. And then
recently Judge Gutierrez from the Federal Court in California
looking at state law, said there is a public performance
right.

So, I think like right there you have a great set up for the fact that
it's something that belongs at the Legislature. That
we think Judge Gutierrez is wrong, that we intend to appeal his
decision all the way through the appeal process. And we have a
long-standing position that we just observe the law, and we've been
observing the law since we started service.

So Judge Gutierrez would suggest that every AM/FM station, bar,
restaurants, stadium, Internet webcast or satellite
radio guy has been operating in violation of California law since
1982. Not one case brought by one act everso let
me get this right: that the Rolling Stones and the Beatles and Joni
Mitchell and Credence Clearwater Revival and
Frank Sinatra and Benny Goodman for that matter, anybody who
recorded a song prior to 1972, for the last
33 years, has been neglectful in protecting their own economic
interests.

We're happy to pay. So, I gave this testimony to congress over the
summer: I think everybody should get paid, and I think everybody
should pay, but to get there, there
needs to be a change in the laws. And it shouldn't be coming from
the bench, it should be coming from the Legislature.

<Q>: So you planned your appeal clearly, timing for when a
resolution may come to this situation, are we talking do
you think this is a year or two out before, if there is any real
decisive impact or...?

<A>: So it's a legal process, right, and appeal is going to take a
while, so I would expect it to be a long-term resolution issue.

<Q>: And I think the question that I've gotten a bunch since this
came out was not necessarily if you have to pay the
royalties for these pre-1972 songs, but what the kind of potential
costs or penalty would be for not having played them
for all that timing you just mentioned. Is there anything how
should investors think about that?

<A>: So, it's very clear, there is no protection under federal law.
So it's not something that happens across the United States all at
once, it needs to happen in each of the 50 states. And then the
people have to come in and claim, and even under California law,
they have to prove they were damaged. So now let me get this
right: the Turtles, who recorded their songs in the 60s, and for 33
years failed to do anything to say they were being damaged,
including back in maybe 1982 when the law was passed, or 1983
or 1984 when it was much closer to when their recordings were
originally released. You would think their damage would have
been far greater back then, for all the terrestrial radio stations that
were playing Happy Together, and some of those other great
songs.

So it's just it's one of the things I think that it rolls out state-by-
state. Quite honestly, I dont think its material. And again we are
happy to pay; we just think there out to be an equitable law, where
everybody pays.

<Q>: Okay. So shifting gears to kind of free cash flow and capital
structure, I want to check down this list, as I think
about, kind of the uses of cash. For a capital expenditures, you
kind of had a trough in your satellite roll outs. Can you
just remind us, again, the cost of the birds that you think, you are
going to have to outlay and when that outlay starts?
<A>: So, its five satellites to be launched or to be built over a
period built launch over a period, ranging from let's say
late 2016, through to about 2026 or 2027. So inclusive, that's an
11-year, 12-year period of time.
And five satellites, today's prices in designs, $300 million a copy,
so it's a $1.5 billion over roughly 12 years call $125
million a year.
<Q>: All right. And on the tax side, federal taxes I think your
[indiscernible] else were $6.5 billion at the end of last
year, when do you see using those up and having to become a
federal tax?
<A>: The pace from now, it looks like we'll start paying federal
taxes in sometime in 2019.
<Q>: 2019. Okay. And then on the interest cost or cost to debt
side, we've seen you pretty efficiently bring that down
over the last couple of years?
<A>: Well, little less efficiently [indiscernible] everybody out
here keeps telling me all the reasons [indiscernible] I
don't know.
<Q>: Yes.
<A>: Your issues are too small, you come to the market too often,
so but you guys don't?
<Q>: Yeah. Well. Potentially, maybe another opportunity coming
up, I wanted to ask you about your 7% exchangeable
notes, is around $500 million of those outstanding that mature at
the end of this year, deep in the money, how do you
think about those in terms of letting them dilute your equity versus
using the capital markets to refinance those?
<A>: We don't have any current plans to refinance them, so
leverage would certainly come down, when they convert
through in December. And we've been talking sort of in general
terms about the buyback being roughly at $2 billion a
year program, we've been running a little bit faster than that pace.
And when we started talking about, we said we could
maintain our sort of leverage target in that sort of original leverage
target in that $3 million to $3.5 million range and
run with a $2 billion program.
Obviously, with a leverage target that looks more like $4 million,
if we chose to, you could you could accelerate that
quite a bit. We haven't made any decisions about doing that yet,
but the company clearly has a lot of excess leverage
capacity, with EBITDA margins at roughly 35% and still rising,
we're among the best in media now. At that level, we
have the best free cash flow conversion ratio in media and we still
have a lot of growth ahead of us. So that whether
you look at it from an equity perspective or from a credit
perspective that you have a pretty attractive piece of paper on
both sides.
<Q>: I don't mean to be flipped. I can't see say this very often, but
it's actually somewhat difficult for you to leverage
up too much given the growth [indiscernible] you're going to put
off a $1.1 billion of free cash flow this year. So right
now I have your gross leverage at around 3.5 times, if you let that
exchangeable note, if you don't use debt to take that
out, that will drop it almost half a turn on your leverage, but your
targets for and potentially you could take it above that
and drift back down. When do you see taking the leverage up to
repurchase more shares or whatever you want to use
your cash for. When does it get to that 4 to 4.5 times?
<A>: Well so we honestly we don't have a date, we don't have a
deadline for it. One of the things that we have said
all the way along is that we aren't necessarily going to operate right
at the target, right. And that we would like to have
room to do take advantage of strategic opportunities they arise.
And I think that a lot of people have argued that you
can take the leverage target up from four times if you want to,
given the sort of cash dynamics of this company. And I
think that's probably right. So we think we have got a healthy
buyback program at this point and we certainly are very
active and looking at things to acquire out there. One of the
challenges we have is that we have those really good
business model, and then awful lot of the properties that we look at
don't look as good. So it's kind of tough when the
business model is rocking as strongly as ours is to find strategic
properties that are as good.
<Q>: Does anybody want to ask a question. We've got a couple of
minutes left. I have a couple more of it. Steve?
<Q>: [Question Inaudible]
<A>: So we do have, spectrum has a limit and we have 25 MHz of
spectrum.
Now I think in a very long-term that you'll find that we won't be up
linking the same programming twice right, like
right now the additional goes up to Sirius system and it goes up the
XM system and we will be able to stop doing that.
So there's an opportunity to double the channels if we want to, or
to go with a fundamentally different product offering,
as opposed to audio you could put in a probably 50 channels of
video up there, you could do a lot of data play.
So there are other things you can do with the spectrum in the long-
term. In the near-term, that one of the great benefits
that connected car for us is that it actually takes our one-way
broadcast product which is unbelievably efficient and it
allows us to add two way features to it. So, we will do that.
<Q>: What is that long-term...[Question Inaudible]
<A>: So, I think that it's I think about it as the XM consolation
gets replaced first and it's really an opportunity with
the newly built Sirius side satellite. So you should think of it is, it
sounds like a long time did you guys it's not very
long for playing parameters. But it's probably about eight to 10
years up.
<Q>: [Question Inaudible]
<A>: That's when I think we would have the first opportunity to
realistically take down the sort of the channels going
up to the Sirius system and replace it with different content. Okay.
Unverified Participant
I'm writing this down, I'm going ask you that in 10 years.
Unverified Participant
Okay, I will bring my walker.
Unverified Participant
We're out of time. Dave, thank you very much.
Unverified Participant
Thanks.